Foreign Exchange Markets

Foreign Exchange Markets Summary

Gerald Maurer

Axia College of University of Phoenix

Introduction

In this paper I will write a lecture that explains the gold standard. I will address the functioning of the world’s major foreign exchange markets. I will discuss in detail the positive and negative aspects of using the gold standard. This paper will also talk how currency fluctuates.

The U.S. dollar has been the dominant currency in the world’s transactions since the end of World War II in 1945. The U.S. dollar was dominant because the U.S. economy emerged from the war virtually undamaged and was clearly the most powerful in the world at that time. Over the next few decades Japan, and other countries in Western Europe and across the world had begun to develop powerful economies, and their currencies were being used along with the U.S. dollar.

Americans enjoyed a world where the U.S. Dollar was the main currency of exchange and stability throughout the last half of the Twentieth Century. As the first decade of the Twenty-first Century now draws to a close, however, a shock may be in store for Americans. The U.S. Dollar may no longer be the main currency of exchange in the world and may no longer be such a desired currency to hold.

How and why a currency increases or decreases in value, the effects of such changes, and the resulting effects on a nation and the world are very important matters to consider. Money, although often thought of as only a medium of exchange, has a value of it own and, as such, is also a commodity, in the same way oil, gold, silver, or corn are commodities (Feiler, Schilling).

The price of money as a commodity is often determined or set as a result of government action and international trade which is observed and then used to determine a value. Such value determination is done by the foreign exchange markets of the world. It is because of such markets that international trade and business can function smoothly or at all (Feiler, Schilling). Foreign exchange trades can occur in a stock market like exchange, similar to the Chicago Board of Trade. Normally, however, it is the major banks in each major nation, such as the Bank of London, the Federal Reserve Bank of New York, and the Bank of Tokyo, which help exchange one currency for another and also, through their purchases of currency “reserves” help set the “price” of all currencies.

This system where the prices of currencies are allowed to fluctuate is a “floating exchange rate” system (FRB New York). This floating system, although it may seem to make sense given how common international trade has become in the modern world, was not the standard used until the very last decades of the Twentieth Century (FRB New York). Prior to the floating exchange rate system the world used the “gold standard” (FRB New York). Under the gold standard nations’ central banks would determine the value of their currency based on how many ounces of gold each one unit of their currency could purchase.

Other nations did the same, so that all currencies had a value that could be compared against a common denominator – gold. Because gold could be held and seen and its value has been known for centuries, a currency exchange set up with gold as its base could be trusted by members of all nations who knew that if they arrived at the Bank of London with U.S. Dollars they would receive British pounds in an amount equal to how many ounces of gold such U.S. Dollars could acquire in England.

This gold standard system was not only stable but it also had the trust of all nations’ citizens. Gold has had a long history of value and its value is very easy for average citizens to understand and trust (van Eeden). When all currencies are expressed as a measure of gold people and businesses were more likely to conduct international trade because they could trust that payment would be made in a form that had value and properly compensated them (FRB New York). The use of a gold standard also helped currencies remain fairly constant in value as re-pricing of currencies, against gold, was rarely done (FRB New York). However, there were problems with the gold standard as time passed.

First, gold costs money to produce, which the gold standard did not account for. This fact meant that every time a nation produced gold or bought it, it was spending more to acquire it or store it then it was using to value its currency. The end of the gold standard, however, came about because the gold standard became too difficult to maintain (FRB New York). For example, as the United States began to import more and more goods from abroad, foreign holdings of U.S. Dollars caused great concern